OM Group: Under The Radar, But Worth A Look

Hard as it may be to believe, there actually are other metals in the world beside gold, copper and rare earth elements. Still, with investors' attention elsewhere, relative value hounds may want to do some due diligence on OM Group (NYSE:OMG). OMG is not a miner, nor a major company, but it has an interesting materials business all the same. IN PICTURES: 5 Tips To Reading The Balance Sheet

OM Group is, to a large extent, in the business of cobalt. More specifically, the company takes raw cobalt (and other metals like copper, nickel, and so on) and turns them into a wide range of powders, coatings, ceramics, additives and other value-added formulations. Like Titanium Metals (NYSE:TIE), and unlike some advance materials companies like Brush Engineered (NYSE:BW), OM Group does not actually own or operate any mines (though OMG does own a sizable interest in a smelter). Instead, they purchase their cobalt. . That makes this company a somewhat different type of commodity play - they can benefit with generally higher commodity prices, but only if they succeed in pushing along higher input prices.

The Quarter That WasThe third quarter was a successful one for OMG. Sales were up 26% in the quarter, though that number is boosted by the inclusion of the acquired Battery Technology segment. On a like for like basis, growth was more on the order of 11%. Growth was led by the advanced materials business (up 17% on flat volumes), while the specialty chemical business posted 4% growth.

Margins were also better this time around. Gross profit jumped 74%, as gross margin jumped almost 700 basis points. Operating profit was likewise much stronger; increasing 243% on a better than 700 basis point improvement in operating margin. (For more, see Analyzing Operating Margins.)

The Road AheadFor OM Group, the future is largely about batteries. Although it is also a major supplier of cobalt-based catalysts, cobalt powder (used for cutting tools) and ceramics, the company gets somewhere in the neighborhood of 40% of its Advanced Materials revenue from the rechargeable battery market. With the acquisition of what is now the battery technology business, OMG has another opportunity to build a bit more independence for itself away from cobalt, while also exploiting the potential ongoing growth in various cobalt precursor products for batteries.

At this point, it is anybody's guess as to which battery technology is going to emerge as the top pick. Johnson Controls (NYSE:JCI) is working on nickel-cobalt cells, A123 (Nasdaq:AONE) is going with iron phosphate cells and LG Chemicals' Compact Power and EnerDel are working with lithium ion technology. Rather than diving in with its own technology (though the company does produce batteries), OM Group seems more content to sit back and focus on developing precursors that could be used by any (or all) of the eventual winners - in other words, focusing on the picks and shovels as opposed to staking a claim and digging for gold. (For more, see The Characteristics Of A Successful Company)The Bottom LineWhat makes OM Group most interesting is the current valuation. OMG trades at close to 7 times EBITDA, which is normal for a natural resources company, but the EV/EBITDA is much lower because of the company's rich cash balance. Moreover, there is actual growth potential here above and beyond the price movement in cobalt. While it is hard to imagine a point where cobalt does not matter at all here, the company's drive to diversify its business and expand further into value-added engineering and chemistry gives it at least a fighting chance to post better returns on capital in the future, and a reason for investors to at least investigate the stock. (For more, see 3 Secrets Of Successful Companies.)